investor protection and corporate ownership - nyu stern.pdfVIP

1 Investor Protection and Equity Markets Andrei Shleifer and Daniel Wolfenzon Harvard University and New York University October 30, 2001 Abstract. We present a simple model of an entrepreneur going public in an environment with poor legal protection of outside shareholders. The model incorporates elements of Becker’s (1968) “crime and punishment” framework into a corporate finance environment of Jensen and Meckling (1976). We examine the entrepreneur’s decision and the market equilibrium. The model is consistent with a number of empirical regularities concerning the relationship between investor protection and corporate finance. It also sheds light on the patterns of capital flows between rich and poor countries and on the politics of reform of investor protection. 1 We are grateful to Edward Glaeser, Simon Johnson, Rafael La Porta, Florencio Lopez-de- Silanes, David Scharfstein, Erik Sirri, and two anonymous referees for helpful comments and the NSF for financial support of this research. 1. Introduction Recent research reveals that a number of important differences of financial systems among countries are shaped by the extent of legal protection of outside investors from expropriation by the controlling shareholders or managers. The findings show that better legal protection of outside shareholders is associated with: (1) more valuable stock markets (La Porta et al. 1997); (2) a larger number of listed firms (La Porta et al. 1997); (3) larger listed firms in terms of their sales or assets (Kumar, Rajan, and Zingales 1999); (4) higher valuation of listed firms relative to their assets (Claessens et al. 2002, La Porta et al. 2002); (5) greater dividend payouts (La Porta et al. 2000); (6) lower concentration of ownership and co